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Alternatively Weighted and Factor Indexes

Asset owners and asset managers are increasingly interested in so-called “smart beta” indexes, a category that includes factor and alternatively weighted indexes. In a series of four FTSE Russell Insights, we explore the concept of factors in depth. We examine the differences between factor indexes and other types of smart beta index, illustrate how factor exposure is embedded in an index and suggest how factors can be combined most effectively.

In this Insights, the second of the series, we explore the differences between alternatively weighted and factor indexes.

Categorization of smart beta
Smart beta is a term that covers a wide range of systematic, index-based investment strategies in the equity markets and, increasingly, in other asset classes. Smart beta indexes depart from the standard index construction methodology of weighting constituents by their market value (capitalisation).

FTSE Russell distinguishes two types of indexes:

Alternatively weighted indexes, designed to achieve specific index level objectives such as greater levels of diversification or lower levels of volatility;

Factor indexes, designed to reflect the performance of factor risk premia in a transparent, rules-based and replicable format.

Types of Smart Beta Indexes

Source: FTSE Russell

Interest in smart beta driven by both risk and return considerations
The 2014 and 2015 FTSE Russell Smart Beta surveys reveal that interest in smart beta amongst asset owners has been driven both by risk considerations (such as a wish to reduce index-level risk or to improve levels of index diversification) and a desire to enhance return through exposure to factor risk premia.

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